Assuming this is a net negative for welfare (and I have no idea whether it is), the simplified answer would be the holdout effect. To do a restructuring, you need substantially all creditors on board. The CDS swap gives a party an incentive not to be onboard. And so a transaction that destroys value (i.e., the company’s liquidation value is smaller than its going concern value by at least the CDS spread) can go through.

The question is, in these circumstances, why wouldn’t the other parties make a side deal to make not crashing the company worth its while?

]]>By: tomrushttp://blogs.reuters.com/felix-salmon/2010/02/02/how-the-teamsters-successfully-played-the-cds-market/comment-page-1/#comment-11725
Tue, 02 Feb 2010 17:45:57 +0000http://blogs.reuters.com/felix-salmon/2010/02/02/how-the-teamsters-successfully-played-the-cds-market/#comment-11725So it would be better to close the CDS market… which leads to a wonky question. In terms of economic theory, why did adding a market (in this case CDSwaps) lower welfare?
]]>By: Felix Salmonhttp://blogs.reuters.com/felix-salmon/2010/02/02/how-the-teamsters-successfully-played-the-cds-market/comment-page-1/#comment-11724
Tue, 02 Feb 2010 17:43:57 +0000http://blogs.reuters.com/felix-salmon/2010/02/02/how-the-teamsters-successfully-played-the-cds-market/#comment-11724I think that empty creditors *can* be a problem, in theory. I’m just not yet convinced that they *are* a problem, in practice.
]]>By: Sandrewhttp://blogs.reuters.com/felix-salmon/2010/02/02/how-the-teamsters-successfully-played-the-cds-market/comment-page-1/#comment-11721
Tue, 02 Feb 2010 16:39:45 +0000http://blogs.reuters.com/felix-salmon/2010/02/02/how-the-teamsters-successfully-played-the-cds-market/#comment-11721Did you change course on the empty creditors issue? I seem to recall you being in Hu’s camp: http://blogs.reuters.com/felix-salmon/20 09/04/18/how-the-cds-market-makes-restru cturings-more-difficult/
]]>